August 02, 2011

Four-Year College Degree Worth Over 15% Return

Here's an interesting article from the Brookings Institution that looks at the value of a college degree. Particularly interesting is that they evaluated getting a four-year college degree using common investment guidelines. from this they determined the rate of return on the "investment" of getting a college degree. The summary:

The answer is clear: Higher education is a much better investment than almost any other alternative, even for the “Class of the Great Recession” (young adults ages 23-24). In today’s tough labor market, a college degree dramatically boosts the odds of finding a job and making more money.

On average, the benefits of a four-year college degree are equivalent to an investment that returns 15.2 percent per year. This is more than double the average return to stock market investments since 1950, and more than five times the returns to corporate bonds, gold, long-term government bonds, or home ownership. From any investment perspective, college is a great deal.

I'll let you read the nitty gritty details on how they did the evaluation, but it looks pretty complete to me (though I'm sure some will not agree with their assumptions -- and they had to make many). But they consider all the key factors IMO: the cost of college, the lost income while attending college, average income for college grads, and average income for non-college grads. It's the most complete attempt I've seen in determining whether or not college is "worth it." Then it goes beyond that question to tell how much "worth it" it is -- by calculating a return rate.

I'll get to some additional thoughts in a minute, but for now, here are a few quotes from the piece that I think are especially interesting:

The average worker with only a high school degree earns only about as much as a college graduate one year out of school. In other words, the average college graduate will surpass the highest earnings of the average high school graduate soon after graduating.

The $102,000 investment in a four-year college yields a rate of return of 15.2 percent per year—more than double the average return over the last 60 years experienced in the stock market (6.8 percent), and more than five times the return to investments in corporate bonds (2.9 percent), gold (2.3 percent), long-term government bonds (2.2 percent), or housing (0.4 percent).

Over a lifetime, the average college graduate earns roughly $570,000 more than the average person with a high school diploma only—a tremendous return to the average upfront investment of $102,000 investment. An associate’s degree is worth approximately $170,000 more than a high school diploma.

We all know that each person is different, and it’s possible (and even likely) that individual college graduates have different aptitudes and ambitions, and might even have access to different levels of family resources. All of these factors can impact earnings. However, the evidence suggests that these factors don’t drive the impressive return to college; instead the increased earning power of college graduates appears to be caused by their educational investments.

In addition, our analysis focuses specifically on the benefits of completing a college degree. Unfortunately, many people start college and don’t finish, resulting in educational costs but not leading to a degree. However, evidence suggests that those who attend college, even if it’s only for a year, earn more than those who don’t start college at all. Depending on how the costs and benefits shake out (the data on this is hard to come by) this could reduce the return to starting college.

There are other reasons why our analysis may underestimate the value of attending college.

Indeed, the recession has not fundamentally changed the math: although a college degree has upfront costs, it important to remember that it is an investment that pays off over time. The evidence clearly shows more education improves your chances in the labor market, in both good times and bad.

Warren Buffett recently told Columbia Business school students, “Right now, I would pay $100,000 for 10 percent of the future earnings of any of you.” (Tucker, 2009). He is not a legendary value investor for nothing: When compared to other investment options, a college degree stands out as one of the best investments one can make.

Fascinating stuff! I recommend you read the entire piece if you find the time.

Now, here are my thoughts:

Yes, this is analysis is "on average." That means some will do better, and some will do worse. That said, 15.2% is the average return rate. So even for those who do a lot worse and "only" get a 10% return, they are doing pretty well indeed.

On the plus side, it's not that hard to do better than average. An above average student at a "decent", inexpensive college who chooses an above average earning degree/major can do much, much better than the masses. It gets to be pretty compelling when you think how lucrative such an investment can be -- as it was for me.

I understand that some people are not "college material" and couldn't get a degree if they wanted. They are not doomed to a career of low earnings necessarily since there are many options for go-getters. But having a high income will be a challenge for most of them. So perhaps an associate's degree is a reasonable substitute. Getting one actually offers a better return rate (though less total income) than getting a four-year degree.

As the cost of college increases (which it seems like it will do for the foreseeable future), the return rate will go down. Then again, there's a long way to go before the return rate hits a level that's in the "skip college" range.

The analysis above doesn't take into account the fact that college graduates often have more employment choices which, I'm guessing, makes them more likely to LIKE what they do for a living. Which option do you think is better: doing something you like and making a good salary or doing something you don't like as much and making a fraction of that? The latter choice offers a lose-lose proposition.

That Warren Buffet comment is pretty compelling, isn't it (remember he's a VALUE investor who likes to pay several times below what he thinks something is actually worth)? I hadn't heard that before.

I know this topic will be debated for a long time into the future, but after reading this I'm even more solidly in the "worth it" camp for most students (assuming they go to college the right way -- keep costs low, get a degree, etc.) What's your take on the analysis?

Comments

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Hmmm.....that sounds good. For me, I know too many college graduates that earn very low salaries. I think it depends on the major and career chosen. As far as other intangible benefits (not financially related) I guess you can say it's worth it.

The more relevant analysis would be to look at different majors as $100K for an engineering degree should pay off, but will it for a history major?

It would be more valuable to know the break even costs for all the different majors so you could decide if going to college in a particular major makes financial sense for you.

But there is a more fundamental question: Why has it gotten so much more expensive?

Tuition has been growing at far more than the rate of inflation for years... but didn't universities get along just fine with much lower (inflation adjusted) tuition in the past?

I suspect class sizes aren't significantly smaller and that professors’ salaries haven't skyrocketed... so where is all that extra money going? If anything administrative costs should have dropped due to technology (i.e. registering via the web instead of filling out forms).

Couldn't a university stand out by cutting the non-educational expenses to the bare minimum and just charging for the education?

"Warren Buffett recently told Columbia Business school students, 'Right now, I would pay $100,000 for 10 percent of the future earnings of any of you.'"

He was talking to students at a prestigious business school -- would he have said the same to a group of communications majors from a small state university?

I agree with Rick's comment above. I'd also like to see the break-even point for different majors. To me, it seems that some students end up "under water" with their student loans, paying far more for their education than the education is worth in earnings -- and quality of life -- over time.

I mention quality of life because of those folks I know who financed both bachelor's and master's degrees, in fields that will top out at $60k/year (maybe). After making their student loan payments, there's not a whole lot of money left in their monthly budgets. This means they're often living paycheck to paycheck, and dealing with the stress which comes with that lifestyle.

Some jobs simply can't be obtained without a college degree(s). I'm thinking of things like a research biologist. The more degrees you have, the better your chances to advance (to a point), so a master's or PhD degree can really pay off. You can certainly succeed with just a BS degree, but the road to better salary & plum projects will be harder & more competitive. It depends on what you want to actually do in your career. At the end of such a career now, I feel my many years in college really paid off in terms of satisfaction in what I do & in salary. However, I also believe that there are many ways to succeed, not just the ones that society puts on a pedestal. Being frugal & hard-working have helped my career as much as anything. If you don't go to college, invest in yourself one way or another--get trained in something, somehow, and be a good employee/business owner!

One of the other things that has to be considered is the expense side. Those who earn more typically run around with a different group of friends and typically spend more on prestige items. So while earnings are much higher with college grads, their lifelong habits are likely to be much higher as well.

I have known 2 people who were way above average in the high school diploma world. One is a woman in our church who has retired from the State of California as a social worker. She never went to college, but her work did pay for some courses to help her out. She started in a small, Midwest area, and worked her way up in a social service office. When she moved to CA, her experience got her a job and she moved up again. Of course, at the way things are going now, college will be required for many more jobs.

The other person apprenticed to a builder. He has a select crew of workers and does top notch jobs. In fact, he does not accept any jobs that are less than $1 million to complete. He has done work in the White House, for other very wealthy people, and for the president's residence in a So. American country.

As to college costs, Rick F., have you ever read any articles by Thomas Sowell, a very knowledgeable economist from Stanford. He says that whenever a third party in admitted to a mixture, it automatically sends prices soaring. For medical it was insurance and for education it was guaranteed student loans. The practitioners can ask for any amount of money and be assured they will get "some" of it. I attended college for 2 years at our church college. This was a year or two before student loans. My entire cost for the whole 2 years, for full load tuition and room was $1,600. That is $800 a year. I just paid more in 2008 for 2 courses & books at a community college - $860 - than for a year at a church college.

Another reason why the Columbia MBA students will earn so much ($120k?) is they'll be working 70+ hour weeks on stressful projects. You have to compare apples with apples. Someone in a trade with lots of overtime could earn just as much.

Correlation doesn't equal causation. My friends who went to college were usually a little ambitious or something -- my friends who didn't almost always were complete failures already. I'm pro-college for most smart people, but these kinds of statistics are meaningless.

The cost of higher education has been debated for many years. However, the nature of the debate has been changing and rightfully so.

Return on Investment is an interesting way to look at this issue. Years ago I started a business and worked hard at raising capital to fund the business. I talked with many private investors, angel investors, potential business partners, etc. I can tell you that nobody would have been interested in investing in my company if my business plan only showed a 15 percent rate of return. So I say that a 15% return is the wrong motive.

In addition to preparing a student for a career, I believe one of the most important reaons for a college education is that it is instrumental in developing the person. College will equip the student with knowledge, but more importantly, it helps to develop discipline, self reliance, people skills, relationships, and problem solving skills. These are issues that reflect a preparatinn for future living and future relationships. This in my mind is the essential reason for a college education.

We have a fundamental problem in this country. The cost of higher education is way too high. A college education is important but far fewer people are able to afford it without the aid of scholarships, federal grants, etc. I don't know the answer, but this is a fundamental problem that needs a solution and soon. Just look at the student loan fiasco. This is a major financial bubble in this country and it's about to burst because students can't find jobs coming out of college. Without a job, how can they pay off their student loans.

The reason I believe the nature of the debate has been changing and needs to change is that our economy is sick. Just look at the real unemployment and underemployment numbers. We need to see a focused effort on increasing the jobs in this country for everybody. Regardless of whether you're a college graduate, a vocational school graduate, or a high school graduate you need to have access to employment. Without a dramatic shift in unemployment, it's hard to justify spending well over $100,000 for a four-year college education.